Thursday, February 05, 2009

U.S. Housing Slump Has ‘Just Begun,’ Says Forecaster Talbott

Feb. 5 (Bloomberg) -- Let’s say you own a $1 million home in Santa Barbara, California.

The house seemed like a steal when you bought it with that adjustable-rate mortgage in 2005. You still love the white beaches and those yachts bobbing up and down in the harbor.

Then you awaken early one morning, troubled that your monthly payments will soon double. You go out to pick up your newspaper and see for-sale signs on five houses on the street. One identical to yours just sold for $500,000.

Are you going to pay the bank $1 million plus interest for your place? John R. Talbott, a former investment banker for Goldman Sachs, poses that hypothetical question in his latest book of financial prophesy, “Contagion.”

His answer: “I don’t think so,” he says. “If I’m right, then this housing decline has only just begun.”

Talbott is an oracle with a track record: His previous books predicted the collapse of both the housing bubble and the tech-stock binge before it. A friend who runs a New York steak house introduces him as Johnny Nostradamus, he says.

What sets him apart from other doomsayers is his relentless emphasis on simple arithmetic. He walks you through the numbers to show how U.S. house prices got so out of kilter with wages, rental prices and replacement values -- the cost of buying a property and building a home. (“Homes in California by 2006 were selling at three to five times what it would cost to build a similar home from scratch,” he writes.)

Five More Years

Talbott’s latest predictions are sobering. The U.S. is only halfway through the total potential decline in housing prices, he says. Home values will continue to deteriorate for four to five years, he forecasts. Adjustable-rate mortgages issued in 2004 and 2005, for example, are only now resetting for the first time, he notes.

Bankers may “try to blame the crisis on poor Americans with bad credit histories, but that is not the real cause of the housing crisis,” he says. “The greatest home-price appreciations and the homes most subject to price readjustment are in America’s wealthiest cities and its glitziest neighborhoods.”

At the end of 2008, a record 19 million U.S. homes stood empty and homeownership sank to an eight-year low as banks seized homes faster than they could sell them, the U.S. Census Bureau said this week. Almost one in six owners with mortgages owed more than their homes were worth, said the same day.

By the time the crash ends, Talbott predicts, homeowners will have lost as much as $10 trillion, with investors and banks worldwide losing almost $2 trillion. And just as the U.S. starts getting over a prolonged recession, the first big wave of baby boomers will retire, depriving the economy of their productivity (and high consumption), he says.

Back to 1997

So how far will the price of your home on the range fall? Citing historical data and trends, Talbott concludes that real prices should return to their average 1997 levels, adjusted for inflation. Why 1997? A 120-year historical graph shows that real home prices in the U.S. stayed relatively flat for 100 years, then began rising in 1981 and surged from 1997 to 2006.

A return to 1997 prices “would get us out of the heady, crazy days from 1997 to 2006 in which banks were lending large amounts of money under poor supervision and aggressive terms.”

How did we get into this mess? Talbott blames everyone from average Americans who caught “the greed bug” to hedge funds and credit-default swaps. The single biggest error, he says, was for U.S. citizens to allow their national politicians to take large campaign contributions from big business and Wall Street -- a theme Kevin Phillips developed in “Bad Money.”

‘No Accident’

“This crisis was no accident,” he says. It began, in Talbot’s view, because the U.S. government was “co-opted” into deregulating the financial industry. Politicians were “paid to deregulate industry,” taking billions of dollars each year in campaign contributions.

His investment advice for this prolonged recession: Hang on to cash and invest in gold or Treasury Inflation-Protected Securities, or TIPS. If he had to invest in stocks, he would put his money in China.

Living in smaller houses with their savings gutted, U.S. baby boomers will face yet another big challenge, Talbott says:

“The toughest job to get in the future will be the elderly person greeting you as you enter the local Wal-Mart.”

“Contagion: The Financial Epidemic That Is Sweeping the Global Economy . . . and How to Protect Yourself From It” is from Wiley (256 pages, $24.95, 15.99 pounds, 19.20 euros).


Shailesh said...

Bhai: Since you put some good points in earlier post, I am going to give my response.

Bhai: Most of the asset class will not grow YOY on a fixed percentage. In property generally after the crash, it will be stagnant for couple of years, later show some moderate growth and when the sentiments are right it will shoot up.

The same has happened to this time, we saw a crash in 96-97and again a boom started in early 2005 and went on to mid 2007. It was during this period the prices of property went in multiples of 3 times and in some cases 5 times.

So by your own logic, there was boom and bust in 90's in India. Also by same logic, it would be not wise investing in 95 as it was bubble. The right time for investing would have been 2004 or 2005, just before the bubble started. Today we are in same situation as 1996, so why buy at this point. Wait till all this sort out and market fall to its correct value, than buy.

When we look at our 97 salaries vis a viz the current salary I feel 9% CAGR is not a great jump. If we look at India during 97 and the current India, we all know that things have changed drastically.

The salary is strictly function of demand/supply. I have an office in Mumbai and I know the salary level have come down significantly. Nobody is getting large checks anymore. Those who signed up in boom time, they will get it, but only if they dont get laid off.

Shailesh the basic change is mind set of people, their expectation. Sizeable number of people with one kid and in some cases with no kid is looking for 3 & 4 BHK.

Look at the cars around, owning a 800 was a big thing in 97 but now even a Octavia is like OK types.

Well, that is all the more reason for price drop. In olden days, people had to significantly depend upon public transport like Bus and Trains. Hence most people wanted to live near train stations. Now with people buying cars, that constraint goes away. People can live in new areas like Thane and Navi Mumbai. Also most new IT campuses are in those areas, so they dont have to travel via public transport. Hence the argument of prime location is kind of moot. People will buy only what they can afford. If 2 people have income to buy 1 crore house, so be it. But these are exceptions, and most such cases work primarily in IT industry, which is going to go thru rough patch.

See, I am long term bullish on India, but short term bearish on real estate that is priced out of whack from fundamentals. Having said that, there are good properties available to buy even today. Just not the ones that cost crores of Rs for 2BHK flat.

Vik said...

I agree with Shailesh. Too much productive money is locked up in real estate putting it out of good use. India has a lot going for it, but this part can definitely correct 50% without causing grief to the common man. High real estate prices help no one except the land owners. Wasn't that the reason, the zamindars were stripped off the land in the 50's and 60's.

Shailesh said...

India's growth rate may plunge to 4.7% in 2009: S&P

I think they need to talk to Chidambaram.

Anonymous said...


You may be right but it looks like you are planning to time the market. This can be dangerous.

All the best.

Bindas Bhai

Bharat said...


You are mixing up markets. That advice (on not timing markets) is for the stock markets which have a very high volatility. Stock markets fall one day and next day before you can buy they are up and running.

Real Estate markets on the other hand a long period of gestation before they resume a bull phase. So the right approach to Real Estate is to time them...all notable real estate investors across the globe including Trump advocate timing the real estate market.

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